Sanoob Sidiq

A free-spirited and an out of the box thinker. Founder of Smile Makers and Kanz Invest. He holds an experience of 8 years in the field of investment and stock trading, and his skills are backed by an MBA degree from School of Management Studies, CUSAT. Read More…

BREXIT and it’s impact on India

The European Union – often known as the EU – is an economic and political partnership involving 28 European countries. It has grown to become a “single market” allowing goods and people to move around. The United Kingdom Prime Minister, David Cameron at the time of his election had promised to hold a referendum on whether the UK should remain in the EU? The referendum has been held and the people of the UK have voted 52:48 in favour of an Exit.

What were the stakes for the British?

The UK is one of 10 member states that pays more into the EU budget than what they get out and only France and Germany contribute more. The UK’s net contribution for 2014/15 was £8.8bn – nearly double what it was in 2009/10.
Post Brexit, Britain would also take back full control of its borders and reduce the number of people coming to live and/or work i.e. it will gain control over immigration within the UK-EU.

What happens next?

Technically, MPs could block an EU exit – but it would be seen as political suicide to go against the will of the people as expressed in a referendum.
The referendum result is not legally binding – Parliament still has to pass the laws that will get Britain out of the EU.
Article 50 of the treaty with EU has to be activated by the UK PM. The current PM has resigned and left it to the next PM to take a decision on Article 50. Once Article 50 is activated, Brexit is certain. Brexit should then be a two year negotiation process between the EU and the UK. In a good case, it is possible that UK postpones invoking Article 50 for 6-12 months while negotiating better terms for the UK within the EU and following up with a second referendum in 2017.

Brexit and Indian economy

It is hard to make a case of any meaningful impact on Indian economy of Brexit – either direct or indirect. The UK is a small trading partner of India – UK alone accounts for only 3.4% and 1.4% of India’s merchandise exports and imports, respectively, as of FY16. Even that should not be impacted as Brexit will change the terms of trade between UK and EU and not with India. FDI flows from UK to India stood at only US$1bn in FY15 and US$0.8bn in FY16; hence, not that significant.

Source: Finance Ministry and RBI

Impact on Indian Companies

Brexit can have some impact on Indian companies that have businesses in UK/ EU.
The medium term impact, if any, will be clear only post the revised terms of trade between UK and EU are finalized. This should take 2-3 years from now.

In the interim, the GBP depreciation is an unexpected positive for companies like Tata Steel and Tata Motors (JLR) that have manufacturing operations in the UK.

Barring these companies, the impact on other sectors like pharma, IT, banks and agrochemicals is likely to be marginal.

Capital outflows

A pessimist may argue that Brexit will lead to FII outflows from India due to risk aversion. While there is no meaningful link between Brexit and Indian economy, India is in a strong position even if there are some outflows. Consensus expects India’s CAD to remain manageable at about ~1.5% of GDP in FY17. Foreign exchange reserves at ~US$363bn seem adequate to withstand volatility in the case of global risk aversion. Net FDI inflows have increased to an all-time high of US$36bn in FY16. Impact of any FII outflows even if it does happen will not be felt by the economy, though stock markets may be impacted in the very short run.

Interest rates

Considering India’s relatively stable macro situation (CAD ~1.5%, Fiscal Deficit ~3.5% and stable inflation), we do not expect any negative impact on the debt markets. Even if there are some FII outflows, which may lead to liquidity tightening, RBI is likely to provide additional liquidity through repos and purchase of Gsecs in the open market operations (OMO).

Uncertainty in EU is likely to lead to USD strengthening and lower global commodity prices. Interestingly, Brent oil prices were down ~4% today. This is likely to aid continued low inflation and provide room for lower rates in India.

The impact of Brexit on all segments of debt markets today has been fairly muted. In the money market (CP & CD) and corporate bond market – yields have moved higher by just 2 to 3 bps. While the yields in treasury bills and government bond market are flat to lower as compared to the levels prevailing yesterday.

The INR was stable and depreciated marginally vs. the USD while appreciating against the Euro and the GBP.

Global events – opportunities for Indian equities?

The following table lists some of the adverse developments in the world over the last two decades, the impact on the stock markets in the short run in India and the returns one year after the event. It is quite evident that on most of these occasions, the correction in the Indian stock markets was a good opportunity to invest for the long term investor. This is so because the nature of Indian economy is one of secular growth and global developments have only a marginal impact on it.

In my opinion, the Indian markets will quickly discount/recover from Brexit. Interestingly, due to focus on Brexit, the steady improvement in the Indian economy has been ignored. The table below gives the key macro-economic indicators.

The correction of Indian equities at a time when the Indian economy is improving on nearly all parameters has created a good opportunity for the discerning investor.

India market cap to GDP ratio, calendar year-ends 2005-15 (%)

The policy direction in India is right and economy is making good progress on most fronts. The economy and equity markets also appear to be in transition from consumption to capex. Impact of higher infra allocation and the several steps taken by government over the last two years is expected to be felt strongly from FY17 onwards with Railways, Power Transmission and Distribution, Mining, Roads and Urban Infrastructure likely to lead growth.

Improving fundamentals of the Indian economy and attractive market cap / GDP lead to a positive outlook for the equity markets over the medium to long term.

In a lighter vein, Gold prices went up by 5% on 24th making Indians richer by $40bn. Equity markets lost ~$30bn in value today. Hence, Indians are actually better off from Brexit!

To conclude, Brexit is not a material event for the Indian markets. Indian economy is on a steady recovery path and valuations are attractive. The correction in markets thus provides an attractive entry point for the medium to long term.